Forex trading is more popular than ever. On average, the global forex market turns over trillions of dollars a day. That’s trillions, with a “T.” This boom in forex trading has attracted newcomers and beginner forex traders in droves, and the forex market is teeming with investors who are new to the world of currency trading.
In my 20+ years in the forex industry, I’ve learned this about starting out as a forex trader: it’s crucial to develop a solid understanding of the fundamentals before jumping headfirst into the forex market. My “Forex 101” educational series should make it easier to understand the complexities of forex trading and shine a light on the largest, most liquid trading market in the world.
Learn more about forex
What is Forex Trading? | What is Currency Trading? | What is a Pip? | Forex Pip Calculator | What is Leverage? | How to Start Forex Trading
What is forex?
Forex is a common shorthand for foreign exchange; both terms refer to the international exchange of currencies (for example, trading U.S. dollars for Japanese yen). Forex market participants usually either have a need for a particular currency (such as when conducting international business or exchanging currencies at the airport) or want to speculate on the movements in the price directions of currencies to generate a profit (this is commonly known as forex trading).
What is the forex market?
The forex market is where the global exchange of international currencies takes place. The foreign exchange market is the largest financial market in the world, with trillions of dollars traded every single day. According to the latest triennial central bank survey from the Bank for International Settlements (BIS), over-the-counter trading in the forex markets reached $7.5 trillion per day in April 2022.
What is the forex market?
Forex trading involves exchanging one currency for another, usually either to hedge the exchange rate to mitigate risk, or to speculate on price movements with the goal of turning a profit.
Hedging
Let’s say there’s an importer in Europe that needs to make a monthly payment in U.S. dollars to its U.S.-based supplier. They’re concerned that the price of the U.S. dollar will go up relative to the euro, which would make it expensive for them to exchange their euros into U.S. dollars for their monthly payment.
The importer could hedge by purchasing a contract that earns money when the euro goes up in value. The hope is that they’ll win in either case; if the euro goes up in value, the importer collects a profit on the contract that offsets any losses incurred when exchanging euros for dollars. If the euro goes down in value, any losses experienced on that contract will be offset by savings made on the exchange rate when it’s time to purchase the U.S. dollars with euros.
Speculation
Forex traders who speculate on the forex market are placing bets on the price direction of a given pair of currencies.
For example, a forex trader might speculate that the price direction of the EUR/USD currency pair will go up. That trader would then purchase the EUR/USD pair (buying euros and paying in U.S. dollars at the prevailing exchange rate) in anticipation that the rate will go up.
Exchange rates
When the euro strengthens against the U.S. dollar, it takes more U.S. dollars to purchase the same amount of euros, thus the EUR/USD exchange rate goes up.
If the exchange rate does go up, each euro is worth more dollars than the forex trader paid for them. The forex trader can then close their position by selling the EUR/USD and netting a profit.
Leverage.
All forex trading is conducted from within margin accounts that allow traders to utilise leverage. In the forex market, leverage refers to the ability to borrow funds from your broker in order to open trade positions. The amount of leverage available varies by broker, account type, platform, and currency pair. Leverage can also be limited and/or restricted by local regulations.
If the margin requirement within a margin account is 10%, that implies a leverage ratio of 10:1. This amount of leverage allows a forex trader to enter the market with a $10,000 position using only $1,000 of margin collateral (or, 10% of the trade value).
More on leverage in the forex market
Leverage has the potential to amplify profits and losses. Learn more by checking out my full guide to how leverage works in the forex market.